Libertarian Part 3: The Greatest Failed Experiment

Limited government proved too succssful for its own good

Exploring Finance

3 key Takeaways

  1. History shows that free markets consistently raise the standard of living for everyone
  2. The Federal Reserve destroys sound money, distorts markets, and enables the government
  3. The smallest government in human history has become the largest in human history


This is a four part essay introducing Libertarian philosophy. The moral aspect of self-ownership was explored in part 1, which focuses on a persons control over their body, the core principle behind social liberalism. Followed to its ultimate conclusion, a stateless society is the only way to fully realize self-ownership. The economic case was briefly laid out in part 2 discussing how fiscal conservatism greatly improves the output of an economy. This article builds on part 2 by showing real world examples of free markets at work.

The best part about free market theory is the overwhelming evidence to support its effectiveness at reducing poverty and increasing prosperity. The reverse is also true, history shows greater government control and intervention reduces the living standard for everyone. Unfortunately, the major “downside” to free markets is they are too successful. With all the wealth created, people experience different standard of livings. When this occurs, people look at the wealth of others and can feel frustrated and angry. In a poor society, everyone is poor so no one experiences envy, but in wealthy societies this becomes a problem.

“Equal opportunity does not mean equality of outcome”

To realize the massive benefits created by free markets, inequality must be acceptable. People must however understand that everyone is better off. Even the poorest people in a free market are better off than “middle class” people from poor countries. When governments attempt to redistribute wealth to “even things out” and make sure the rich pay their “fair share”, they end up shrinking the economic pie.

“Wealth redistribution for an economy is equivalent to doing a blood transfusion from your left arm to your right arm and spilling 80% of it on the floor.” - Peter Schiff

Not only is it expensive to redistribute wealth as the money flows through bureaucracy, but you are moving money from the most productive members of society to the least productive (assuming the wealthy earned their money in a competitive free market and not via government regulation). Moving wealth from producers to consumers means less production is flowing into society while consumption of goods increases (without production), the economic pie is shrinking from both directions (less production, more consumption).

Society would be far better off letting the free market find the best use of wealth and capital (of which private charity would most certainly be included). Unfortunately, this is not a campaign platform that would get any politician elected. There are far more consumers than producers, so wealth redistribution is a massive selling point for the vast majority of voters. Thus, the great success of free markets, also caused its downfall as politicians saw massive wealth that could be promised to make things more “fair” in exchange for votes. In doing so, they have killed the golden goose.

The role of the Federal Reserve

While government interference in the market creates massive inefficiencies, when combined with a central bank, the economy is left with a two headed monstrosity that destroys the mechanism that makes free markets so successful. Libertarians generally follow the Austrian School of Economics, which puts primary responsible for the economic boom bust cycle on the Federal Reserve.

The Austrian Business Cycle Theory (ABCT) focuses on sound money backed by silver and gold where interest rates are determined by the market. Interest rates are the “price of money” (the cost to borrow money), so the signals given by interest rates are vital for a well functioning economy. This goes back to supply and demand curves from part 2.

When there is not enough savings (supply of money) and the economy might overstretch due to excess spending, interest rates naturally rise to draw money out of the economy and into savings. When there is a glut of savings, rates (i.e. prices) fall which pushes money back out into the economy as the opportunity cost for spending outweighs savings.

Similarly, when demand for money (borrowing) rises, prices (interest rates) rise which can curtail bad loans. Only the most sound businesses, who can afford higher interest rates, will borrow money at higher prices. Similarly when demand for loans falls, so will interest rates to entice borrowers back.

This natural balance and equilibrium is critical for business and consumers alike. If business are investing for the future and borrowing money, interest rates will rise which will naturally attract savings. When the future arrives, there will be ample savings to consume the investments created by the business. The interest rate is being set by millions of consumers and business all making decisions about the future in a symbiotic relationship.

When the Federal Reserve gets involved, it decreases or increases interest rates as a way to hammer on the gas or slam on the breaks. It strips the price mechanism away from millions of market participants and centralizes it into a few academics who believe they are smarter than the market. Layer on money printing (now dubbed quantitative easing), which destroys the value of the currency, and it creates massive problems for the economy at large. Furthermore, the Fed enables the government to further distort the economy by borrowing money at artificially low interest rates. This pulls capital away from the more productive private sector.

For these reasons, the Fed, in partnership with the government, destroys the currency. This is not a new phenomenon which is why a Central Bank was not established when the country was founded. The founders new the massive risk with having a central bank. The corruption of money is the first thing governments do to extend their power and influence. Whether it’s Rome shaving silver off their coins or the Federal Reserve engaging in quantitative easing, inflation becomes a hidden tax the robs people of their purchasing power and thus devalues the production of their labor. Ironically, this affects poor people the most because they have the least amount of assets.

Regardless of the word used, inflation is the hidden taxation that governments engage in to disguise the true cost of their activities. The true currency of our world should be silver and gold, or whatever the free market determines. This is why the rallying cry of many Libertarians is “End the Fed!”. They recognize the massive destructive powers of monetary manipulations and the devastating effect it has on the poor. Furthermore, you now have an economy and stock market that hangs on every single word the Fed utters. The market could move 50% or more depending on Fed policy. This is way too much power for a single institution. In many ways, the Fed Chair is the most powerful person in the world.

So how did we get here? Below is an extremely brief history of the entire free market movement that started with the Enlightenment and its role in the formation of the US. It attempts to explain how the US arrived at the current situation today of unsustainable debt and an ever widening gap between rich and poor. It shows how government intervention, combined with the Federal Reserve, have left the US economic engine a mere shadow of its former self.

The Evolution of Classical Liberalism

The Age of Enlightenment began in the 1700s with philosophers such as John Locke. As stated on Wikipedia, The Enlightenment included a range of ideas centered on the sovereignty of reason and the evidence of the senses as the primary sources of knowledge and advanced ideals such as liberty, progress, toleration, fraternity, constitutional government and separation of church and state. From this movement came Adam Smith, who became the “Father of Capitalism” pushing for free markets to unleash the human potential.

The United States became an incredible experiment in these principles. The country was founded on the idea of self-ownership and property rights. The Constitution was written to decentralize power and protect the individual. The structure of the Constitution was written to only grant the federal government explicit powers as stated in Article 1, section 8, such as the right to declare war. If the powers are not directly granted to the federal government, then it is not within their scope. Unlike the Federal Government, as stated in the 10th amendment, the powers not delegated to the United States by the Constitution, nor prohibited by it to the States, are reserved to the States respectively, or to the people. The States rights are limited by Article 1, Section 10, with restrictions such as the right to coin money. In summary, the Constitution explicitly states what the Federal Government can do and what States cannot do.

While the Constitution was certainly not perfect (hence many amendments), and completely neglected to address the morally reprehensible issue of slavery, it was still a giant leap forward for humanity. Historically, there had been a ruling class that controlled and held all the wealth while completely suppressing the vast majority of the population. This new experiment, brought on by the enlightenment, allowed people to realize self-ownership and keep the fruits of their labor. With this new found incentive, the explosion of wealth was absolutely astonishing. Below are two charts showing world-wide GDP growth over the last 2,000 years. Notice that the second chart is the same as the first chart only logarithmic, which is used to mathematically remove the visual effects of exponential growth. Even using logarithms the trajectory of growth unleashed by capitalism is incredible.

World GDP: Linear Growth

Figure 1: World GDP: Linear Growth

World GDP: Logarithmic Growth

Figure 2: World GDP: Logarithmic Growth

During the 1800s, the world saw a massive improvement in every measurable statistic from life expectancy, wealth, food production, population, education, infant mortality, etc. This improvement continues to this day despite what the media may indicate. We live in the most peaceful and prosperous time in all of human history. For anyone feeling pessimistic, Information is Beautiful has a daily chart that shows this improvement happening each year.

Even though improvement continues, the growth rate has slowed substantially in recent decades. In the 40’s and 50’s GDP reached as high as 8%+, followed by the 60’s and 70’s where GDP growth reached as high as 6% some years, but has failed to cross 4% since 2000. Furthermore, specific to the US, while poverty had been declining for generations with a shrinking wealth gap, this trend has started to reverse. What happened?

With such a massive surge in wealth in the 1800s, governments saw a pool of money that became too large to ignore. Prior to 1913, there was no income tax except for a brief period during the Civil War. Most tax revenue came from excise taxes. During World War 1, the income tax was introduced, at a whopping tax rate of 1% for anyone making less than $463,000 in 2013 dollars! Around the same time, there was a secret meeting at Jekyll Island in 1910 which laid the foundation for the Federal Reserve Act of 1913. In many ways, this was the beginning of the end to the great US experiment.

The US had launched two US Federal Banks prior to the Federal Reserve Act, but Andrew Jackson had ended the experiment, recognizing the blatant conflict of interest and moral hazard. Unfortunately, the great privilege wielded by printing your own currency became too attractive, leading to the Federal Reserve system (the Fed) we have today.

It didn’t take long for the powers of the Fed to be felt with the roaring twenties as money supply expanded rapidly, fueling excess optimism. Eventually the artificially inflated bubble came crashing down leading to the Great Depression. Prior to the Great Depression, most economic contractions were swift because the market corrected before optimism became too excessive. The Federal Reserve’s expansion of the money supply allowed the party to continue long past what would have been possible, leading to a far bigger bubble.

While the Fed claims responsibility for the Great Depression, they argue it’s because they did too little, while conveniently ignoring their role in sowing the seeds. When you get someone hopped up on drugs and they come crashing down, the issue isn’t that you didn’t keep feeding them drugs, but that you gave them drugs in the first place (by rapidly and artificially expanding the money supply)!

At the time, the dollar was still linked to gold which greatly constrained the government’s power to spend and the Feds ability to print. To remove the constraints, FDR made a very controversial move by first confiscating gold in 1933, paying people $20.67 per troy ounce, and then re-valuing gold at $35. It became illegal for US citizens to own gold. This made it easier for the Fed to finance World War 2 when tax revenues could not cover the cost. It is important to note, that World War 2 did not end the Great Depression as many people currently think.

Near the end of World War 2 came the Bretton Woods Agreement which set the dollar as the world reserve currency backed by gold. Foreign governments were allowed to convert their dollars to gold, which gave them absolute confidence in the dollar. The dollar was as good as gold. This may have been the most important event of the 20th century for the US economy. It put the US dollar at the center of the global monetary system.

In the post-World War 2 era, the government and Federal Reserve still had enough sense to reel in spending and pay down the federal debt. This enabled them to adhere to the Bretton Woods agreement. Paying down the debt gave foreign countries more confidence in the dollar. Furthermore, the debt reduction led to another economic boom.

Even though capitalism and free markets had done an incredible job at reducing poverty, increasing life spans, eliminating child work, and shrinking the wealth gap, there was a wealth gap in the economy (as there will be in any free market system). To try and solve this “problem”, LBJ launched the great society in the 1960s. This, combined with the Vietnam War, led to more proliferate borrowing by the government as tax dollars could not cover all the costs.

As debt increased, countries began calling on the US to convert their dollars into gold. Unfortunately there was not enough gold to redeem all foreign demands. Eventually, President Nixon had to close the gold window by refusing to deliver gold in exchange for dollars, which officially ended the Bretton Woods agreement. The 1970s became very challenging as massive inflation was coupled with a stagnant economy which became known as stagflation.

The modern era: unsound currency and a widening wealth gap

With the dollar quickly losing ground, the US had to act or it risked losing the exorbitant privilege of issuing the world reserve currency. Two events occurred to reaffirm the dollar reserve status. First, the US negotiated with Saudi Arabia and OPEC to establish the petro-dollar system. The US pledged military support in exchange for forcing oil transactions to be settled in dollars. This ensured a strong global demand for dollars despite gold no longer backing the currency. Second, was Fed Chairman Paul Volcker in 1979 raising interest rates to unprecedented levels of 20%. This helped to stymie inflation. It wasn’t without significant consequences such as double digit unemployment, but Volcker did what was necessary to protect the dollar.

Although Volcker took the hard and necessary steps to protect a dollar no longer backed by gold, his predecessors would not have the same courage and conviction. From 1981 onward, interest rates took a steady path downward. As lending standards loosened, excessive spending became the norm. Since Greenspan took the helm of the Fed in 1987, the playbook has been to fight every deflating bubble by trying to pump air back into the bubble. Essentially, every hangover has been “cured” with more alcohol instead of letting the economy recover. A free market recovery would have been slower and more painful, but it would have been built on a sounder economic foundation.

The economy was not allowed to heal. Instead, the country has limped from bubble to bubble like a heroin addict constantly in need of more monetary stimulus in order to stay afloat. Each bubble requires ever larger doses of stimulus to keep the economy going. Each round of quantitative easing and monetary stimulus from the Fed is always bigger than the previous round because a smaller or equal amount would not be enough to reflate the bubble. The price for this economic experiment is inflation.

To disguise the ridiculous notion that unlimited money printing doesn’t cause inflation, The Fed is now claiming that inflation is “too low” and more needs to be done to bring back inflation; however, this must seem absurd to the common individual. Yes, consumer prices, as measured by the CPI, have not moved much, but that is very misleading for several reasons:

  1. The formula to measure inflation has changed
  2. The outsourcing of manufacturing to the developing world, specifically China has helped keep prices low
  3. The massive productivity gains over the decades have helped hide the true cost of inflation. Instead of falling prices, as would happen in a true free market economy with increased productivity, prices have still been rising.
  4. Inflation does exist in assets. Houses have exploded in value, the stock market surges to all-time highs, and commodity prices continue rising.
  5. The dollar reserve status allows the US to export its inflation to the rest of the world. Foreigners take our dollars, buy our debt, and send us physical goods in return (good deal for us, lousy deal for them).

Considering points 2, 3, and 5, consumer prices should have been falling for the past 3 decades, not rising. The deflation myth makes no sense. Who puts off buying things because they might be 1-2% cheaper a year from now? Instead of slowly falling prices each year, the US experiences inflation which is a hidden regressive tax.

Most tax systems are progressive meaning the wealthier pay a larger share. The inflation tax is exactly the opposite. Anyone with wealth and assets sees the benefit of increased prices, while lower income workers without assets are left confounded by their loss in purchasing power. Increased regulation certainly plays a part of higher prices (for example in housing and health care), but the efforts of the Fed to keep blowing up bubbles is the most insidious as it is harder to see. This is fully laid out and explained by ABCT. The boom bust cycle from the Fed combined with fractional reserve banking, explain many of the issues facing our economy today, including the Great Recession.

Post Great Recession

The biggest problem with inflation is the difficulty in explaining and understanding its pernicious effects. The middle class is feeling squeezed but cannot quite explain why. Millennials are having to buy first time homes that cost $500,000+ but were only $50,000 thirty years ago. The same issue exists with college tuition. Unfortunately, salaries are not 10x higher than they were 30 years ago. People are frustrated with the current economic and political system but don’t know who to blame.

While the country has had political polarization since its founding, there seems no doubt it has gotten worse in recent decades. Look no further than the election of Donald Trump. In many ways, the American people were so frustrated, they decided to lob a grenade right into the center of Washington DC. Unfortunately, because Trump is not a conservative, he only succeeded in shifting both parties further left from a fiscal standpoint.

The liberals should be thankful for Trump. He destroyed the republican party, and opened the door to many big spending liberal programs (e.g. $2,000 stimulus checks). During his presidency, he eliminated any vestiges of fiscal conservatism. Unfortunately, this will only lead to more inflation and greater economic problems that will sow further seeds of discord and mistrust among the general population.

The US now ventures into uncharted territory. I built a dashboard examining the US Debt with a separate article for a detailed analysis. The Republicans and Democrats are much more similar than many people realize. Neither party disagrees on 95% of annual US spending, instead they both play to the extremes on the 5% they disagree on (increased military vs a larger safety net). Both are complacent with trillion dollar a year deficits. Since COVID, the Fed has financed nearly all the debt since international buyers cannot (or will not) absorb the trillions of dollars being issued by the treasury.

Even before COVID, the economy was in trouble. The Fed no longer has the option of raising interest rates without blowing a hole in the federal budget. It continues to inject ever larger doses of stimulus into the market with less effect each time. Many democrats are now proposing Modern Monetary Theory (MMT), which basically calls for unlimited money printing to cover the cost of all the programs.

As discussed in part 2, a tax rate of 100% on the the rich would still not cover the cost of government spending. This is not a revenue problem or an issue with the rich not paying enough in taxes. This is a massive spending problem.

The Libertarian Party, offers solutions that would restore America to the economic juggernaut that made it the wealthiest country the world has ever seen. Unfortunately, if there is one thing Republicans and Democrats agree on, it’s keeping out competition. Even though it is the third largest party, and appears on ballots in all 50 states, very few people have even heard of the Libertarian party. Ironically a lot of people would classify themselves as “fiscally conservative and socially liberal”, which is exactly why Libertarians are not even allowed on the debate stage. The two parties have a monopoly on the conversation. Also, no one gets elected by promising to reduce spending and take away freebies.

The Republicans and Democrats strive to out promise each other with money we don’t have which is why the Federal Reserve is the guiltiest party in destroying the American economic engine. Without the Federal Reserve, these promises would have to be paid from tax revenue and people would not vote for them. Instead the tax is paid in higher inflation which is much harder to see and understand. This is not how true capitalism works!

“We do not live in a free market economy. It is crony-capitalist”

As mentioned, the criticism laid on the Fed above is founded in Austrian Business Cycle Theory. There is an excellent book by Peter Schiff called How an Economy Grows and Why it Crashes. It uses a parable to tell the United States economic history in about a 2 hour read. The rise and fall in the US is not a unique story. Empires with sound money create massive wealth, over extend themselves (colonies are money losers not revenue generators), dilute the value of their currency and eventually collapse. The US currently benefits from it’s dollar reserve status, but if that is lost then look out below! Even looking beyond empires, anywhere free markets are practiced, the economic story is always the same.

The Remarkable Story of Chile

Look no further than modern day Chile with the highest GDP per-capita in Latin America, nearly 50% higher than Mexico or Argentina.

How and when did this happen? Although the rise of Pinochet in the 1970s was very violent, he brought in a group of economists known as the Chicago Boys. They brought free market economic reforms influenced by Milton Freeman from the University of Chicago. If you look at the chart below can you can see the inflection point for when the economy of Chile started to take off. Even under dictatorship rule, the free market economy grew rapidly, outpacing all the other countries.

Note: For those rightly critical of Pinochet, and his killing of 80,000+ people, this is far less than the millions massacred in communist and socialist countries like China, Cambodia, and Russia. One death is too many, but be sure to acknowledge the risk of a powerful state.

This same trend applies anywhere free markets are given the ability to work (Hong Kong, Singapore, South Korea, etc.). Massive increases in the standard of living as people are lifted out of poverty. Unfortunately, Chile is starting to fall into the same trap as the US and begging for more government intervention to reduce inequality. As the US learned, this will only cause the economic pie to grow slower and widen the gap between rich and poor.

Wrapping up

This article attempted to briefly summarize the history of free markets. Entire centuries were covered in one to two sentences. I am not attempting to restate arguments that have already been made. Instead, I wanted to introduce some basic ideas to potentially pique a readers interest. I know what it’s like to feel extremely frustrated with the current political environment. I also recognize the difficultly in latching onto either the Democrats or Republicans. This frustration led me to better understand the US economy and research the greatest economic experiment in human history.

How did the greatest experiment fail? Government. The smallest government in human history produced the most wealth in human history and then became the largest government in human history.

“Free markets created the middle class, governments destroyed it”

As mentioned above, the constitution was specifically written to contain the powers of the federal government. Almost immediately, politicians looked for ways around these constraints, and 250 years later the Constitution has been left in tatters. The founders understood the perils of Democracy which is why they structured the US as a Republic, not a Democracy. Unfortunately, democracy and mob rule was too powerful a force. Their biggest failure was not recognizing how quickly the constraints on Federal power would deteriorate.

“Democracy is the same as two wolves and a lamb deciding what to eat for dinner” - Ben Franklin

This is why the moral argument becomes even more critical. Governments can only exist under the threat of violence through taxation. Without a morally consistent principal that the initiation of force is always wrong, the growth of the US government became inevitable. Shrinking government will never work, because the governments nature is to only get bigger. If coercion (taxes) were removed from the beginning, then maybe we could realize the great prosperity delivered from true unbridled capitalism. Up until now, we have only had glimpses. No matter how compelling those glimpses are, many powerful people have a vested interest in not allowing a free market to exist.

As much as the left criticizes the private sectors pursuit of profit, it pales in comparison to the destructive powers of government. Even if you buy into false ideas like Walmart destroying small towns, you have to admit they have never killed anyone. Furthermore, this is another misunderstood story, because it ignores the incredible value Walmart offers to its customers. Regardless, a private company will never be as dangerous as a government. As they say, if you killine one person makes you a murderer, but killing 100,000 people makes you a politician (or if you take the entire 20th century, 262 million people). To achieve a new level of prosperity, we must fully reject the government and the violence they perpetuate!

In part 4, I offer some concluding thoughts about how to move forward in a world that feels very backwards.

Disclosure: The content herein is my own opinion and should not be considered financial
advice or recommendations. I am not receiving compensation for any materials produced. 
I have no business relationship with any companies mentioned.